With ten years to go to deliver the Sustainable Development Goals (SDGs), attention is on mobilising domestic revenue to support governments in providing effective public services. Taxation is a key instrument in providing governments with a stable flow of funds, and improvements in the efficiency of tax systems can enhance their revenue generating potential.
But tax systems affect more than just financing for public budgets. How taxes are levied, who bears the burden, and how it affects business and individual choices is critical to the relationship between the state, society, and the economy.
In this blog, four of our experts provide insights on the interplay between taxation and development – from informal taxes to civil society, and tax reform to economic transformation.
It is estimated that low-income countries (LICs) need to spend an average of 19% of GDP more than is currently planned to achieve the SDGs by 2030.
Stepping up domestic revenue mobilisation through taxation is therefore gaining international attention. Yet, there are signs that some developing countries are already close to capacity. We need to help LICs to build better tax systems that can raise more revenue, but that are also more sustainable, fair, and equitable.
LICs already spend relatively more than today’s high-income countries (HICs) did historically when they were at similar levels of development. Effective tax rates in sub-Saharan Africa are above the world average, and there is also evidence to suggest that some LICs are achieving relatively high levels of tax ‘effort’ and may not have a great deal of untapped potential.
There are clearly advantages to the push for more taxation, which will remain a primary focus for public revenue:
- it provides a more sustainable and predictable source of revenue;
- it helps strengthen governance and build institutions that are more accountable to citizens;
- and higher levels of taxation have been associated with spending geared towards social sectors (PDF).
So, there’s more to tax systems than financing public spending. One important link between the two is that there is greater tax compliance where the government is trusted to spend in the right ways and on the right things. This means that raising the overall level of taxation blindly in LICs can have negative consequences. Placing too much pressure on tax systems to deliver revenue can exacerbate inherent unfairness.
Avoidance strategies are more likely to be at the disposal of the rich and multinationals, while tax administrations prioritising revenue mobilisation may place unfair pressure on compliant taxpayers. Investment and demand in the economy could also be discouraged, while regressive fiscal policies place an uneven burden on the poor and widen inequalities that can be destabilising for growth.
Striking a balance between more ambitious revenue targets and tax fairness, equity,and development is therefore essential. It requires supporting countries to build better tax systems that are compatible with economic growth and the developmental, structural, and political context.
Informal taxes and transfers are often left unaccounted for when discussing social protection and fiscal welfare in developing countries. But research shows that they should be considered alongside official tax and social protection programmes.
In collaboration with the Institute for Fiscal Studies (IFS) under the TaxDev project, ODI has started innovative work on how far ‘informal’ taxes (payments made locally to fund public goods) and transfers (payments made between households or into community-run savings) affect redistribution and inequality. Our research (forthcoming), funded by the UK Department for International Development (DFID), has revealed some surprising findings to date.
For example, we found that the number of households in Rwanda and Uganda which received informal transfers either equaled or outnumbered those who received official state transfers.In both countries, informal and local taxes affected more people than official tax programmes, and both formal and informal taxation approaches were significantly raised to fund community-level infrastructure. The overall impact of these transfers also either equaled or was greater than redistribution by the state.
Our research also looked beyond Rwanda and Uganda to assess the situation of other developing countries. Across over 90 developing countries, an average of 28% of the population lived in households that received such payments. In Rwanda, this rose to over 90%.
Another surprising finding was that across these 90 countries, domestic transfers between households in each country far outweighed international transfers sent from abroad, although the latter are on average far higher in value. On average, 24% of the population across these countries received such domestic transfers.
So, the effects of informal taxes and transfers on inequality are mixed. Higher international transfers tend to go to richer households, while domestic transfers help income flow from urban to rural areas, protect the elderly and other low-income family members, and smooth seasonal fluctuations in income and food security.
The research is still in its early stages, but it’s clear that informal taxes and transfers should not be ignored in any analysis of redistribution and fiscal incidence in developing countries. They both contribute to protecting the poor but are less progressive than formal income taxes and social assistance. They also mean that the ‘affordability’ of state-run tax systems must be considered in light of these informal and long-standing obligations.
Looking to move beyond mainly technical support to governments, international donors are increasingly interested in the potential of civil society to strengthen tax systems. However, typical donor support to civil society is often based on several assumptions.
For example, rather than assume civil society organisations (CSOs) naturally want to work on a progressive agenda for tax reform, donors should deepen their understanding of where the pressures to reform tax systems stem from, and where this aligns with the interests of different civil society actors. Our recent ODI report found that CSOs disproportionately favoured working on international, alcohol, tobacco, and mining taxes (as opposed to income taxation, for example).
Donors also tend to assume that CSOs need tecnical tax training to be effective advocates in strengthening tax systems. We spoke to civil society organisations engaged in tax reform in eight countries,such as Action for Economic Reforms in the Philippines.
While we did find clear gaps in technical tax knowledge, a more notable feature of influential CSOs was how they worked in politically savvy ways. They often combine analysis with advocacy; public mobilisation with behind-the-scenes structured engagement; and build coalitions for reform across government and civil society. These are the kinds of soft skills that technical training alone cannot provide.
Working on tax can also be difficult for CSOs, especially when public trust in government is low. It’s easier to mobilise the public to campaign against unpopular taxes, than it is to advocate for increased domestic resource mobilisation through taxation. Donors would do well to understand tax reforms as an outcome of political contestations between an ecosystem of actors (not just the result of policy analysis) and think strategically about how and in what ways they can influence these contestations.
When considering the link between taxation and development,our first thought generally goes to corporate tax incentives,which are often in the form of tax holidays and rebates provided to encourage investment. While these entail losing a part of the tax revenue, they can contribute to overall economic growth by facilitating investment.
Research has generally focused on whether such incentives work, how they should be structured, and whether they are really necessary to attract investment. The debate, though, should be much broader. How can tax systems and tax incentives promote growth in job-creating sectors and, ultimately, economic transformation
There is much more to taxation and development than tax incentives. In developing countries, for example, trade taxes are one of the main sources of government revenue. Either in the form of tariffs charged on imports or on exports, trade taxes can shape the patterns of production and consumption.
For example, high tariffs levied on a product can encourage its domestic production of the same product at the expense of imports. Export taxes can also be charged on goods to discourage exporting and to promote domestic processing. An efficient and predictable customs system can make it easier to trade and invest.
Whatever form they may take, trade taxes ultimately affect the production pattern of a country by altering relative prices, which impacts the choices of both consumers and producers. Other taxes – such as mining royalties, environmental taxation, and taxes on land – also have behavioural effects. They shape the choices of investors, ultimately affecting a country’s development path.
So, when looking at taxation and development, we should look beyond tax incentives and consider the myriad of other issues that can shape behaviours and economic performance, and, in the end, growth and development.